Climate change is rising up the risk agenda, and as with other emerging risks in the past, Ned Holmes explores the reasons why captive insurance is well set to offer a solution
Climate change is a threat that is becoming impossible to ignore. Last October, a UN body on climate change warned that the world has just 12 years to limit global warming to a maximum of 1.5 degrees centigrade, or face significantly increased risk of hazards, such as droughts, floods, poverty and extreme heat.
For a third consecutive year, environmental risks dominated the Global Risks Perception Survey in the World Economic Forum’s 2019 Global Risks Report.
In the report, environmental risks accounted for the top three risks by likelihood (extreme weather events, failure of climate-change mitigation and adaptation, and major natural disasters) and four of the top five risks by impact (failure of climate-change mitigation and adaptation, extreme weather events, water crises, major natural disasters).
Climate change and its impact is becoming an issue that must be addressed by businesses and risk managers. Stuart King, president and CEO of Strategic Risk Solutions (SRS) Europe, suggests that first and foremost it is important to view it from a risk management standpoint. He explains: “Climate change is high on the risk agenda, and irrespective of how you look at it from an insurance or a corporate standpoint, businesses have to do something.”
Ellen Charnley, president of Marsh Captive Solutions, explains: “From extreme weather events to water crises, the effects of climate change are increasingly exposing businesses to new and unpredictable risks.”
She explained: “Sometimes these effects are catastrophic in nature or interfere with an organisation’s ability to do business, which in turn increases operational costs impacting organisations.”
She adds: “But for every global uncertainty that leads to gaps in traditional coverage, there is a captive solution that can be used to mitigate the risk and improve the parent company’s climate resilience.”
What can captives do?
The flexibility of captives means they’re well suited to providing solutions for emerging risks, which may be unquantified and lack risk data, be difficult to price, and lack commercial market solutions.
Alex Gedge, business development and captives executive at JLT Insurance Management, explains that coverages for emerging risks like climate change are becoming more common in the captive market.
She says: “Traditional property, casualty and liability still make up the majority of captive insurance coverage written, but more so they are used for cyber, supply chain, employee benefits and other coverages which represent a big risk to businesses.”
King outlines the role captives can play in supporting a company’s management of climate change risk. He says: “Climate change is an emerging risk, which is very hard to quantify. The captive can act as an incubator for that unquantifiable and difficult to price risk. Companies already have that risk in their balance sheet, so, the captive just formalises it, understands it, and quantifies it.”
“The captive can then act as a conduit to transfer that risk to the insurance or reinsurance market.”
Charnley highlights: “For every global uncertainty that leads to gaps in traditional coverage, there is a captive solution that can be used to mitigate the risk and improve the parent company’s climate resilience.”
“Captives can improve organisations’ climate change resilience through multiple solutions, including access to coverage, funding for catastrophic losses, insurance-linked securities, and coverage for wind, flood, and business interruption.”
She offers an example: “Pollution and smog in China that shuts down a large city for days can lead to some contingent business interruption losses that are insurable, but coverage can be difficult to secure through commercial markets.”
“These limited options can be a driver for captive formation.”
An opportunity
Clearly captive insurance has a lot to offer businesses who are looking to better mitigate their climate change risk, but what sort of opportunities does this emerging risk offer the captive industry?
Charnley believes it provides proving grounds within which captives can show their effectiveness as a risk management tool, especially for emerging and unquantified risk–perhaps a timely opportunity, with the number of lawsuits brought against or involving captives (mostly micro captives) in recent years.
She says: “Any new risk that is difficult to insure becomes an opportunity to demonstrate the versatility of captives. In the past, captives may have focused on writing traditional or predictable risks but as utilisation has increased over the years, we see many captives writing high-severity, low-frequency risks too.”
“Climate change is one of several trends that may alter captive owners’ strategies and while this is certainly a challenge, there is also opportunity here to demonstrate the inherent flexibility that a captive can provide when addressing emerging risks.”
King highlights the opportunity the captive industry has to help businesses take action against climate change, and to be a force for good.
He explains: “On a macro level, the insurance industry is doing a lot to support climate change, in terms of natural weather and hazards. That is the work that companies such as Munich Re and Swiss Re do through the governmental bonds that they issue.”
“At a granular level the insurance industry needs to be taking action. The insurance industry cannot just be the last resort, we need to address the risk.”
Carbon Risk Solutions
A practical way of addressing that risk is to aid companies with their overall reduction in carbon, something which King is doing through Carbon Risk Solutions (CRS), a programme launched in 2015 by SRS to identify how risk management techniques can support corporate commitments to becoming carbon neutral.
CRS developed a risk identification methodology in 2016 that included the use of captives.
The methodology was a response to a comprehensive analysis undertaken by CRS on the impact an unforeseen increase consolidated carbon emissions might have on a multinational’s ambitions to become carbon neutral.
Following on from launching awareness for the programme last year, CRS are putting on a number of workshops with sustainability directors and risk managers in 2019. King’s ambition is to partake in an innovation sandbox and have multiple clients by the end of the year.
He comments: “We are talking with a regulator at the moment to be part of an innovation sandbox. We then would take the clients from theory, to case study, to execution. In a years time I would hope that we have 10 customers in the innovation sandbox.”
Ahead
Despite the suitability and opportunity discussed, climate change remains an emerging risk that is rarely covered by captives. Gedge, however, suggests this is beginning to change.
“With increased data and analytics capabilities captives are able to expand their remit to a wider variety of risks,” says Gedge.
“Environmental risks have increased in profile and frequency in recent years, so these risks are increasing in relevance for businesses who are exposed to the impacts of climate change.”
“It’s not a risk that is commonly covered in captives, but it’s something that is getting higher up risk managers’ agendas.”
Charnley concludes that as climate change rises up risk managers’ agendas, captives need to be considered as an appropriate risk management tool.
She notes: “Current and prospective captive owners should consider the advantages to writing property, wind, flood, business interruption, and supply-chain coverage into their captives in order to protect against these climate-related risks.”
